Transcript of a Conference Call on the 2010 Article IV Consultations with the United KingdomWith:
Ajai Chopra, Mission Chief for the United Kingdom and Acting Director, European Department;
Kevin Fletcher, Deputy Division Chief, European Department; and
Olga Stankova, Senior Press Officer, External Relations Department
Tuesday, November 9, 2010
MS. STANKOVA: Good morning, everybody and good afternoon to those in the United Kingdom and other parts of the world. Welcome to the conference call on the release of the IMF 2010 Article IV Consultations with the United Kingdom. We are releasing today the Article IV Staff Report, Public Information Notice, and a number of associated documents. I hope you all had a chance to review them on the IMF’s Online Media Briefing Center. The documents and the conference call are under embargo until 9:30 a.m. Eastern Standard Time, which is 1430 GMT.
The conference call will be held by Ajai Chopra, Mission Chief for the United Kingdom and Acting Director of the IMF’s European Department. Now I will pass the microphone over to Ajai for introductory remarks, and then we will take your questions.
MR. CHOPRA: Thank you very much, Olga. In my remarks to start this press call, I’m going to touch on four things. I’ll first talk about how we see the outlook for the U.K. economy. I’ll then say a few words about the fiscal policy stance, and then turn to monetary policy, and finally to the priorities in the financial sector.
So starting with the outlook: Economic recovery is underway in the U.K. Over the last six months, growth has been above expectations. As you know, the third quarter data that came out recently showed an annualized pace of growth of 3.2 percent. We expect the recovery to continue, but at a more moderate pace of 2 percent in 2011 as the economy goes through a difficult, but necessary, rebalancing.
Specifically, private and external demands are expected to become the drivers of growth as the public sector retrenches to bring down the very large fiscal deficit. But this forecast is subject to considerable uncertainty, although we see the upside potential and the downside drifts as broadly balanced. With this uncertainty, it means that policymakers must remain vigilant and flexible. Encouragingly, unemployment has stabilized and even edged down in recent months, but it remains at too high a level. As the Managing Director of the IMF has emphasized on a number of occasions, the crisis will not be over until there is a marked fall in unemployment. This means it is all the more important to lay down the preconditions for strong, sustainable, and equitable growth.
Turning now to the fiscal stance of the U.K. The fiscal deficit was 11 percent of GDP in 2009, a post-war record, and one of the highest deficits in the world. Consequently, debt is rising rapidly. With this in mind, the government has embarked on a strong and credible multiyear plan to reduce the deficit. The government’s plan does three things: First, it greatly reduces the risk of a costly loss of confidence in public finances. Second, it regains fiscal space to cope with future shocks. And third, it supports a balanced recovery. Inevitably, fiscal consolidation will dampen short-term growth, but will not stop it. This near-term cost of fiscal consolidation in our view is outweighed by the longer term benefits.
Regarding the composition of fiscal adjustment, the plan appropriately focuses on spending measures, which are spelled out in the recent Spending Review. But there are also revenue measures, notably the rise in the VAT rate in 2011. In the supplement to the staff report, we’ve outlined our views on the Spending Review. I should note that the staff report itself was done before the spending review came out so we take up the issue of the spending review in the supplement to the report, which is a part of the package that was released. I should also mention that in the supplement to the staff report we emphasized the effect of spending reductions on the vulnerable segments of society needs to be monitored closely.
The final point on the fiscal side is that it will be important for the authorities to be adaptable if downside risks materialize. For example, if there is the threat of a prolonged and sharp downturn, the pace of structural fiscal consolidation may need to be adapted, provided the overall fiscal strategy is on track and there is sufficient fiscal space.
Turning now to monetary policy: The current monetary stance remains appropriate for now to offset the contractionary impulse in fiscal policy and keep inflation close to target over the policy horizon. Yes, inflation has remained stubbornly above the 2 percent target, but in our view this has been mainly due to a series of price-level shocks, including the VAT rise in January 2010 and the past appreciation of Sterling. These elements have more than offset the moderating impact of slack in the economy. With another increase in the VAT slated for January 2011, headline inflation is likely to remain above target next year as well. But we expect inflation to fall back to target by the end of the policy horizon as these shocks dissipate and spare capacity and wage restraint keep underlying prices in check.
Finally, on the financial sector. The U.K. banks have made progress in repairing their balance sheets, and funding conditions have improved since the height of the crisis. Nevertheless, challenges remain and continued progress is needed to enhance resilience to future shocks and reduce risks to the economy and the taxpayer, especially as the U.K. is home to a number of large and internationally active financial institutions. In particular what we advise is that supervisors will need to maintain pressure on banks to first, further increase banks’ capital buffers overtime to comply with the higher standards set under the Basel III Accord; and second, to develop robust new funding models, especially as crisis-related public interventions are phased out. On the regulatory front, we encourage the authorities to continue providing leadership toward agreement on an ambitious international package. The U.K. is also moving to a new supervisory architecture for both micro- and macro-prudential oversight. These institutional changes will need to be managed with great care to mitigate operational risks during the transition.
Before I close, just a couple of more words about the documents we’ve released. As I’ve already mentioned, the staff report has two components—the main staff report, but also a supplement that deals with the more recent information. But in addition to that, we released a set of selected issues papers that accompany the staff report and provide some of the analytical underpinning for our views, and there are six papers that we have in this separate report. They cover issues such as estimates of the output gap, and inflation dynamics when output gaps are large and persistent. We look also at the lessons from large fiscal adjustments, using international evidence. We’ve done some simulations of possible fiscal rules to see how these rules would have worked if they had been in place in the past and also how they might work in the future. We have an assessment of recent developments and the outlook for major U.K.-owned banks. And, finally, we also have a short piece that looks at the recent and pending reforms of the U.K. financial sector regulatory and supervisory framework.
Before I turn it open for questions, I should mention that the Deputy Mission Chief, Kevin Fletcher, is also with me, and we’ll both be taking your questions. Thank you very much.
QUESTIONER: I’d like to ask if you could expand a little on the risk that the report highlights of implementation of the spending cuts. Could you explain a little bit more about what the risks are and what some of the main challenges you think could be? Thank you.
MR. CHOPRA: Well, the point that we make on this is that when you are doing cuts of the magnitude that are being envisaged by the U.K., it does result in challenges in a number of areas. Firstly, there is the old issue of the actual execution, but here the U.K. does have a good record. It’s got a good expenditure management framework. The entire framework of doing this in the context of a Spending Review that looks at both departmental expenditure limits and also annually managed expenditure is carefully done, and they’ve outlined the key parameters. So it’s going to be important that they act, that they deliver on this.
Another element is the planned cuts in social benefits where they’re working on improving the targeting these cuts. The savings that these measures will provide have been vetted by the newly created OBR. That gives additional confidence to the savings that can be achieved from this. But more broadly speaking, I think the issue is to ensure that strains on public service delivery are well managed and are looked at very carefully. And also the distributional aspects will need to be looked at as the cuts are implemented.
QUESTIONER: Hello. Two questions if you don’t mind. The first relates to the 2010 growth forecast. Given that the third quarter turned out to be stronger than you had anticipated, did you consider raising that forecast? I note from the language you were using earlier that you were saying the recovery will sort of moderate next year, and yet you’re forecasting a 2 percent growth rate for next year. I’m just a tiny bit confused where your view of 2010 is right now.
The second question is to do with a comment you made in the sort of interview that you published with the documents this morning. You say that it’s important that the consolidation be fair, which means that it will be important to protect the poor and the vulnerable. Having seen the spending review, you’ll be aware that in the U.K. the issue of fairness is very much discussed and debated. I mean, what’s your view of how fair this is?
MR. CHOPRA: Firstly on the 2010 forecasts, you’re quite right that the forecast will indeed need to be revised to take into account the new data for the third quarter. We have refrained from updating our forecast at this point for two reasons. The first is that the details of the third quarter data, in terms of the expenditure components, will not be available till later this month. And we have a strong preference for updating our forecasts only when we get the details from ONS of the national accounts.
The second aspect here is that we will come out—we now have a quarterly update of the World Economic Outlook. The next quarterly update of the World Economic Outlook will be, I believe, in January 2011. At that point we will have the details of the third quarter data, and we will then do a comprehensive—take a comprehensive look—and revise our forecasts. The point that I made earlier is that yes, growth in the second and third quarters did surprise on the upside. For the third quarter, as you’ll see in the supplement, our staff forecast was actually closer than many other forecasts to the outturn. So we’d already anticipated a fairly high print. But, you know, as we say, looking forward we see this coming down. Maybe my colleague, Mr. Fletcher, has something to add on this.
MR. FLETCHER: Just one other additional point is that the Q4 number, because it’s the last number of the year, doesn’t have a huge impact on the annual growth rate. Three-quarters of the year is already determined, so the range in which Q4 would affect the annual growth rate is not that large. But certainly it’s possible that the number may be revised upward somewhat.
MR. CHOPRA: On your question about the distributional impact, just a few words on that and again, I’ll ask my colleague to say more if I missed something on this front. The impact of the fiscal consolidation on the quality of public services and income distribution has indeed been a heated debate topic in the U.K. At the time of the Article IV Consultation discussions when we were in London—and you’ll see this also in our concluding statement—we had said that the distributional impact could be mitigated by putting greater emphasis on reducing public sector compensation premiums and also by achieving a savings in social benefits through better targeting. We have said that this can also dampen the negative growth impact of the spending cuts because reducing transfers to the more wealthy may have smaller effects on consumption. We were, therefore, pleased to see that the October Spending Review did take steps in this direction. For example, by eliminating the child benefit for higher income families and also announcing plans to increase public sector employees’ pension contribution rates. As you well know, the Spending Review itself includes an analysis of the distributional impact on households of tax, social benefits, and expenditure measures. They have this in an annex. We, ourselves, have not done an independent analysis of the distributional effects. This is too soon after the Spending Review, and it would require a lot of resources for us to do this carefully. So we have not done our own analysis, but I would point out that, you know, there are other independent analyses available such as by the Institute for Fiscal Studies, which have done their own analysis.
QUESTIONER: In the past and in your sort of, your final consultation in September, you’ve been sort of very supportive of the government’s programs of cuts. And in the thing today, you talk about how the Director’s generally supported the frontloaded fiscal consolidation. But in other publications by the IMF you’ve been less clear that you thought that sort of early cuts were necessarily a good thing in the WEO and the Fiscal Monitor. And, indeed, in a blog by Olivier Blanchard recently, he said that “A frontloaded adjustment could destabilize the recovery.” I just wondered why you felt that Mr. Blanchard’s sort of views on frontloaded adjustments do not apply to the U.K.
MR. CHOPRA: I think we’re fully consistent across our various documents and what various people in the IMF are saying. I think if you look at a blog by Mr. Cottarelli and Mr. Blanchard when they talk about the issue of frontloading, they do make it a point to say that there does need to be a non-trivial first installment of adjustment measures to establish credibility. I would emphasize two additional points over here, and I’m going to be a bit quantitative in answering this question. I think it’s useful to look at what our forecasts would have been if the consolidation was not frontloaded, and if instead it was evenly phased. If we had even phasing in the U.K., this would mean that 0.7 percent of GDP of tax increases that are planned for 2011-2012 would have dropped out for that year. If we have a fiscal multiplier of 0.4 for the tax increases, this would imply growth would have been 2.3 percent in 2011 rather than our forecast of 2 percent. But, you know, it’s also possible than even phasing could have reduced confidence, and then growth might have been even smaller. Therefore, one can think of the frontloading in the U.K. as buying insurance against risks of a costly loss of confidence in public finances, with the premium of this insurance being 30 basis points of growth in 2011. Now this is something that the government would have to make a judgment as to whether they wanted to take out this insurance with this sort of a premium cost, and they decided to do so. I think one also needs to keep in mind the political economy over here. This is the first coalition government in the U.K. in a number of years, and I think it was important for this coalition government to show its determination that it could get the fiscal consolidation on track with a very solid start.
QUESTIONER: Okay, can I follow up with just a quick second question? You also in the report today talk about, you know, what would happen if things—if the economy doesn’t turn out, it doesn’t recover as quickly as possible. You discussed that a little bit earlier on. You said at one point that “The uncertainty surrounding the current cyclical outlook puts a premium on contingency planning.” Now I’m sure you’re aware there’s been lots of talk about the need for a Plan B if things don’t work out. Is this you saying that you think that we need to have a Plan B, either fiscal of monetary, should the economy take a turn for the worse?
MR. CHOPRA: What I think is—let me restate the points that we were making. As we’ve said, the risks around the outlook are unusually large, but they are balanced both in the upside and the downside in our view. The first point is that if there is a deviation from the baseline, the first port of call is, of course, letting fiscal automatic stabilizers work and the fiscal automatic stabilizers in the U.K. are relatively large. We also need to keep in mind that there is the option to provide additional monetary stimulus if some of the downside risks materialize. However, if as we’ve said in the report, if there is a prolonged and significant downturn, it will be necessary to adapt fiscal consolidations plans. So I think the threshold for any additional discretionary action is a fairly high threshold. And I think if that was to materialize, the fiscal consolidation plans would need to be looked at again. What we have said in the report is that we would favor looking at temporary and targeted tax cuts to achieve this. We also emphasize that any such move should be matched also preferably with longer term entitlement reforms to maintain credibility. But altering the pace of structural consolidation can be done only if there’s sufficient fiscal space and if market conditions permit.
QUESTIONER: It’s a follow up really to that one. Could you just give us some indication as to what would qualify as an unexpected and significant or prolonged downturn? Are you talking about another, a double-dip, recession or are you just—could it be low positive growth?
MR. CHOPRA: Look, it’s very difficult to be concrete about this. I think a lot will depend on the nature of the shock. I don’t think just a dip for a quarter would qualify in my view. I think it would need to be much more substantial than that. I think, you know, when growth is lowit’s quite possible that it could turn negative for a quarter. That’s certainly not what we envisage. We don’t think that is very likely. It’s not our central scenario. But I think the threshold for additional discretionary action would have to be quite high. And as I said, much will depend on the nature of the shock. Is it a U.K.-specific shock? Is it a global shock? And one cannot pin these things down in advance.
QUESTIONER: Just a separate question. What is the IMF’s assessment of whether quantitative easing of these sorts carried out in the U.K., whether or not that’s worked?
MR. CHOPRA: I can only talk about the U.K. I’m not going to talk about other cases. For the U.K. we have a long box in the staff report that goes through all the arguments, that goes through the quantification, and I have nothing really to add to that box. We came to the conclusion that it has been effective in achieving its goals. You know, I really have—as we said, that it’s boosted confidence in the U.K. It created positive wealth effects, and it improved the supply of credit to the corporate sector. We have a working paper that we put out on this last year. It was one of the first working papers that came out on quantitative easing. This has been followed up by work by the Bank of England. I think as so, and we have nothing to add to what we have said in the report.
MS. STANKOVA: I think we would like to thank everybody for joining the conference call today and to remind that the embargo will be lifted at 9:30 a.m. Eastern Standard Time, which is 1430 GMT. We wish you a good day.